A Credit Spread: Is The Popular Option Trade Really a Mirage?
The Truth About High Probability Credit Spreads with Options
OTM Credit spreads are one of the most popular
instruments used in Option Trading. The question is why. The answer
is simple. The OTM credit spread is the easiest spread to understand for
beginning option traders.Next
question:does this make it a good
The truth is that OTM Credit Spreads have a high
probability of making a profit. However, along the way to realizing
a gain with this trade, you have a lot of risk and stress involved.
For example, the average Credit Spread trader will face 100% losses on this
trade several times a year while trying to make a modest 5 to 10% a
month. What happens is that eventually most Credit Spread Traders meet
their doomsday. Sooner or later, virtually all option traders who use
only OTM Credit Spreads wipe out their trading accounts.
Let's look at the "Computer Glitch" of 2010 when the
DOW dropped 1000 points in a matter of minutes. Those doing Credit
Spreads on this day lost on average between 70% and 90% of their
portfolio. What happened is that the volatility rose drastically and the
trades moved into that "danger zone" where they lose 100% 10 percent
of the time. The Credit Spread trader doesn't realize that the 10 percent
of the time they lose can happen AT ANY TIME. Most people think that they
will have 9 wins followed by 1 loss, but this obviously is not how the law
of probability works. It's not uncommon for an OTM Credit Spread trader to
face a catastrophic loss on their very first trade, and once this happens,
there is no way to recover since a winning trade will only bring back 10%
on the remaining capital.
Alternative Trades to Credit Spreads
San Jose Options does not teach Credit Spreads. We
use them combined with other spreads and for adjustments, but we never place a
credit spread alone. This is one of the riskiest trades that you can do
with options. Our options course is focused on Safety, and we have
strategies that help us to protect our capital and keep us away from high risk
strategies such as this one.